HFI Financial

Group of Companies

 

FAMILY BUSINESS SUCCESSION AND ESTATE EQUALIZATION

Most parents feel strongly about ensuring that their children are treated equally in their will. For many,

this is a moral obligation, and, on the surface that would seem easy to accommodate. Often, however, this is

not the case. Most estates are not totally liquid at the death of the testator and some assets are harder to divide

than others. This is particularly true when a family business is involved, especially when many business owners

have up to 80% or more of their wealth tied up in the family enterprise.

How do we deal with the children who are not involved in the business when the children who are will receive the family

company shares as their inheritance? While the desire may be to treat the children equally, it is under these circumstances

that the focus shifts to treating the children fairly.

For the children who are working in and/or managing the business it is far more beneficial to them not to have to report

or answer to siblings who are not involved in that business. For the non-business siblings other estate assets or cash

could certainly be used as a substitute for company shares. If other estate assets are used for this purpose, however, one

must take into consideration the tax implications involved in this transaction and whether or not these assets are liquid

enough to satisfy the needs of the beneficiary. Often, a common method of obtaining estate equalization or fairness is

through the use of life insurance, either on a single life or joint life second to die basis.

In using cash, specifically where that cash is created using the death proceeds of life insurance, the issue of the value of

cash versus shares has to be dealt with. Is there a need to provide cash to an heir who is not involved in the family business

on a dollar to dollar basis? In other words, if the value of the shares equal $500,000 should the sibling not involved in the

business receive $500,000 in cash? In my opinion, the answer is probably not. The sibling who receives cash is free to do

whatever he or she wishes and is not subject to the risk of business represented by the share ownership. While the argument

could be made that the non business sibling does not participate in growth of the business the truth is they assume none of the

risk. If all siblings were in agreement, however, the sibling who received cash and wished to take a more involved interest in the

company could purchase shares from the other siblings and participate in growth – and assume risk – at a later date. I

suppose one might ask what discount should there be for receiving cash in lieu of shares? This is very subjective and a question

which would require full discussion amongst all family members.

Of course, the above remarks are aimed specifically at operating businesses which have the usual management needs of most

enterprises of that type. In the situation where the family business in question is an investment company or a real estate holding

company both of which generate income without the usual concerns of operational management the treatment could be different.

The investment or real estate holding company could almost be characterized as an annuity and often only the oversight of a

single manager is required. In this example it could be appropriate to divide the company

shares amongst the family heirs in a manner which is consistent with the wishes of the testator without the need to substitute

cash for shares for those family members not intimately involved in the running of the business.

Whichever form of family enterprise is the case, the testator should always be aware of the dangers of inequitable estate distribution,

namely, family discord as well as potential estate litigation. Full communication is often the answer to all types of potential problems

and risks in developing a business family estate plan. When the family participates in full discussion directed at formulating an

effective family business succession plan a lot of the potential risk dissipates.

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FAMILY BUSINESS SUCCESSION AND ESTATE EQUALIZATION